Reinhart: With Yellen, we will continue to see a Fed that works with an apparatus that gives signals about rates. Bernanke limited the forward guidance to telling us what the committee thought about it. Yellen will take it as her responsibility to flesh that out.

El-Erian: The Fed understands that they are trying to shift the wealth effect and animal spirits, which will then shift the wealth effect. Once again, we will get downward revisions on the economic forecast. The question about the Fed’s mandate isn’t about willingness, it’s about effectiveness. The other question is about markets. We saw that in May with the mere mention of taper.

Reinhart: We’ve turned the term premium (compensation for risk) negative. There is a risk when you disconnect Treasury market from the rest of the world. You encourage the reach for yield. We saw a case study that some investors were not aware of risks they were taking, being encouraged by the Federal Reserve.

El-Erian: Adds that people are pushed (rather than pulled) into trades. With this combination of low rates, QE, and guidance, people are being pushed to take more risk.

There isn’t much policy flexibility left if there’s another systemic crisis, El-Erian says. Moreover, a lot of the “systemically important” countries are outside the developed world, so the potential “pothole” is a lot bigger and supply of “spare tires” is a lot smaller, he says.

Reinhart: Yellen believes she has a tool for forward guidance. She will keep policy dovish for a long time, but she can explain that the best contribution to humankind is to work on price stability (inflation). She can walk away from a policy contibution she doesn’t have confidence in, but she will continue to have forward guidance.

Reinhart: I think everyone’s expectations of what central banks can and should do is permanently altered. We’re delegating policy decisions to central banks, and they are the most undemocratic institutions there are.

Next panel on the new regulatory environment is underway. Former Securities and Exchange Commission Chairwoman Mary Schapiro says regulators sometimes overshoot, sometimes undershoot, but eventually get to the right place.

Meanwhile, the crisis shows the importance of having a “new mindset” on compliance and regulation.

Jim Millstein, CEO of Millstein & Co., says regulation is respondng to a crisis that has created much more complicated players as a result of forced mergers and other combinations that have highly concentrated assets among a handful of institutions.

“I think we’re all struggling with what to do with these institutions,” he said.

Millstein, who served as chief restructuring officer at the Treasury, says the advent of such huge corporations with huge market power in financial services may eventually invite some antitrust scrutiny.

Schapiro says the need for reform of money-market funds still keeps her up at night even though she can’t do anything about it.

Her real worry, she says, centers on the new regulatory regime for over-the-counter derivatives. While the work so far has been excellent, there’s no money to ensure compliance. In reality, regulators aren’t in a position to regulate the central clearing houses where risk has been concentrated, Schapiro said.

Millstein says the shadow banking system has had a “free ride so far.”

“Even though we’ve forced central clearing of derivatives,”there remains a whole class of products that remain unregulated, he says, citing Warren Buffett’s warning that such products pose a threat as “financial weapons of mass destruction.”

We’re moving on to Abenomics. Next up are Paul Sheard, chief global economist at Standard & Poor’s Ratings Services and Koichi Hamada, a special adviser to Japanese Prime Minister Shinzo Abe’s cabinet.

Sheard questions the wisdom of increasing a consumption tax. It won’t be the disaster that a tax hike in 1997 proved to be when it was accompanied by other fiscal consolidation measures, but it’s probably not the wisest move right now, he says.

Hamada says that with excess capacity equal to 1.5% of gross domestic product, he is worried about the negative impact of the consumption tax, but notes that monetary policy is “very accommodative.”

So is the Bank of Japan succeeding in boosting inflation expectations and escaping the deflation trap?

There are some positive early signs but it’s too early to tell, Sheard says. Still, there’s been a dramatic shift in the message from the Bank of Japan, which had previously held that the key to ending deflation wasn’t aggressive monetary policy, but the need for structural reform.

That argument, however, is self-defeating and rejects the core idea of inflation-targeting, Sheard says.

New BOJ Gov. Haruhiko Kuroda has crossed the monetary policy Rubicon and is focused on boosting inflation expectations, he says.

But at the same time, long-term Bank of Japan watchers, who have repeatedly seen monetary policy makers “snatch defeat from the jaws of victory” are still wary, he says.

Foreign investors have been massive net buyers, around $120 billion worth on a net basis, of Japanese equities, Sheard notes. If investors worldwide get frustrated and start unwinding trade and the domestic investor’s mindset hasn’t shifted toward risk, the market is very vulnerable to a very sharp selloff, Sheard says.

What lessons does Japan’s experience hold for U.S. and other policy makers?

Sheard says foreign policy makers in the West learned from Japan’s pioneering of quantitative easing and forward guidance earlier in the crisis, although Japan didn’t do them very well. Now, Japan is learning from its pupils.

The other lesson is that it’s important that monetary and fiscal policies not work against each other, he says, noting that “stimulus” is a dirty word for fiscal policy makers in the U.S.

First off, is there such a thing as a bubble? The phenomenon is a market-mediated feedback that’s like a “social mental illness” that’s marked by excessive enthusiasm, fueled by the news media, and feelings of regret among people who have missed out.

In the end, it even starts to affect people’s perception of themselves. When it bursts, it’s extra devastating because it wipes out people’s self esteem and can even lead to a “negative bubble.”

It once used to be somewhat disreputable for economists to even talk about bubbles, notes Shiller.

Fellow panelist Lewis Alexander, chief U.S. economist at Nomura, says economic models to tie down fundamentals aren’t that good. So a lot of what drives financial markets can’t be derived from fundamentals, he says.

“The ability of the economics to tie these things down isn’t what we’d like it to be,” Alexander says, saying it’s a bit of an illustration of Shiller’s academic work on excess volatility.

So should there be a definition of a market bubble?

Alexander says there’s an important distinction between bubbles and systemic risk.

“There are many bubbles that don’t generate systemic crises and we need to think about those things differently,” he said. For instance, the Nasdaq stock bubble didn’t generate a systemic crisis because it didn’t have the credit component that have marked other crises.

The Fed has only “partial responsibility” for the housing bubble, Shiller says. Interest rates were a “jagged path” while housing prices soard, though the Fed didn’t help by cutting rates in the midst of the bubble, he said.

The efficient markets theory, pioneered in part by Shiller’s Nobel prize-winning counterpart Eugene Fama, encouraged a “hands-off” approach by the Fed by arguing that there was no such thing as bubbles.

Recently, there were negative rates on inflation-indexed bonds, TIPS, going out 15 years, Shiller notes. “You’d think governments would view that as a huge opportunity to borrow and do infrastructure investment,” he says.

The dot-com bubble got people thinking about where things were going technology-wise, while the housing bubble saw people put their entire life savings into a property and then leverage it, Shiller says. That made the housing bubble much more destructive.

It’s important to find ways to harness risk-taking appetite in productive ways, he says.

Next up is Bank of Mexico Governor Agustin Carstens, who is giving the Bagehot lecture. He will address the challenges of emerging market economies for central bankers. “Central banking has become interesting and fun again,” he said.

Carstens: Before, we had a solid framework to work with to keep the inflation target in place. Asset price considerations played a seconary role.

When the financial crisis hit, central bankers took on the task of playing a resolution role. Oftentimes, you’ll hear that the central banks are the only game in town. That’s impacted emerging markets, he says.

What are the challenges emerging markets central bankers face? EM central banks are starting to normalize central banking policy. That will imply higher interest rates. In emerging markets, it’s easier for inflation to spin out of control. The challenge is to resist pressure to be overburdened with too many rates.

Another challenge: Nontraditional monetary policies have created massive and volatile capital flows in and out of the economy, including a lot of carry trade types of transactions. That impcated the exchange rate and interest rates in EM economics.

High yield covenant lite bonds are being sold, and unwinding those trades could become tricky, Carstens said. Some of this can be tolerated as it shifts capital to emerging markets from advanced economies, but “some is excessive”, he said. Too much capital in a short period of time can generate damage given limited ability to absorb capital.

To prepare for capital inflows to reverse, Cartsens says best practices include: maintaining a low current account deficit, international reserves, and contingent international financing like Mexico and Colombia. Central banks can’t deal with these repurcussions from outflows on their own, he said.

Inflow and outflow of capital are both challenges, Carstens said. It reflects uncertainty of when tapering will take place and economies will begin to normalize their monetary policy. As we wait for the normalization procss, we should put as much gravel in the road for capital inflow. “Gravel” refers to something that makes the inflows more thoughtful and less abrupt, he said.

Growth is below potential, Greenspan says, which is evident from demand and supply side of the economy.

From the demand side: look at subsectors of GDP arrayed by life expectancy. Structures led the recovery in every prior recovery until this one. It means you are looking at two different types of structures: those with less than 20 years duration and those with more than 20 years.

Why are corporations building so much of the former? They have no other place to invest it. It seems that the economy is at an “odd equilibrium”, he said.

One way to measure economic uncertainty: Spread between 5-year Treasurys 30-year Treasurys measures slope, Greenspan says. The so-called “term-strcuture” accelerates in a way that is unprecedented in American history, he said.

From Greenspan’s new book, he says: Republicans are at the forefront of the movement forward in social benefits. He refers to a former Republican president, who told him that Republicans are at the fore because they are constantly afraid Democrats will move forward and take the credit.

If you look at the receipts and expenditures of the federaal government, the biggest are total social expenditures on the one hand and deficits on the other. That’s the main cause of the business uncertainty about the longer run, Greenspan says. “How the government is going to be funded is an open question,” Greenspan said. “How we resolve this I don’t know, but the solution has to be political.”

Greenspan: I wish I was as optimistic about any solution. We should have had higher tax rates earlier on. If we had adequately funded the social benefits system, tax rates would have been a third higher than they are now. That would have created a surpluss than later reverses.

Questioned about tax cuts he argued for over a decade ago, he says in both cases he’s focused on long-term accrued budget balance.

Asked whether, with record corporate profits, is it the incentive structure (i.e. buybacks) for business that is undercutting investment? Greenspan says the cash flow is being engendered by different forces than the ones that create business confidence.

The first panel of the afternoon is ready to start, focusing on fiscal priorities and how to balance spurring growth while reducing debt. TIAA-CREF CEO and former Fed official Roger Ferguson, and economists Carmen Reinhart and Laura D’Andrea Tyson.

Tyson, who chaired the Council of Economic Advisers in the Clinton Administration, says the return to austerity after a mild stimulus by historical standards amounted to “premature contractionary policy.” She says the blame for the misstep is partly due to the economic profession’s longstanding skepticism of the efficacy of fiscal policy.

“We had essentially a situation where fiscal policy was making the short-term situation worse” while the Fed was unable to offset the impact since interest rates were near the zero bound. That left no other option but QE, which eventually seemed to lose some of its mojo, she says.

Fears of bond vigilantes, who never showed up, and the notion that stimulus crowds out private investment–an assertion backed by little evidence–hamstrung efforts to more effectively address the crisis, she says.

Reinhart says the U.S. did better than a lot of countries in the wake of the crisis and says that concerns about the relationship between debt and growth haven’t gone out the window. Countries with higher debt are doing worse, she notes.

Reinhart co-authored with Ken Rogoff work on the relationship between debt and growth, including the well-received book, “This Time Is Different.” Reinhart and Rogoff were in a fight with Paul Krugman and other critics, however, after an MIT study challenged the conclusions of a Reinhart-Rogoff paper that tied debt above a certain threshold to lower growth and often served as a rationale for austerity measures.

Tyson says U.S. has stabilized debt-to-GDP ratio and notes that policy makers have long been aware that health costs were eventually going to drive it way up. “I don’t think we have an out of control debt problem right now,” she says. “

Meanwhile, health-care costs have been growing much more slowly than previously expected since 2006. If that trend holds, the problem gets pushed out much further, Tyson says.

Reinhart says she’s “much less optimistic” about where the U.S. is on debt. The situation is better relative to other big economies, but that’s cold comfort. Meanwhile, the issue of “hidden debt” is a worry, she says citing Fannie Mae and Freddie Mac and other unknown issues.

Reinhart says higher taxes and lower benefits are likely in store. She notes that negative real interest rates are a type of tax on bondholders.

Ferguson notes that Fannie and Freddie have been a source of added revenue in recent years and that the U.S. has “better demographics” than some of its peers.

Still, the U.S. is an aging population and must get to grips with it. As far as slower health-care spending, health executives think it might be in part a consequence of the recession, anticipation of the Affordable Care Act and improved technology.

There are three separate problems that have been exacerbated, says Ferguson. The debt ceiing is a near-term problem. The second problem is the medium-term issue of deleveraging, while entitlements present a longer-term challenge.

Beddoes: The probability that politicians will come to some sort of discussion and disagreement will be very small. This is no longer about coming to an agreement about the economics. The reason we don’t get there is because the political dynamic isnt there.

Tom Easton says the argument isn’t about the dysfunction. It’s about who benefits. “Washington in my mind won’t function well unless it functions less,” he says, noting that Washington has become involved in so many perameters of its functioning that it’s difficult to resolve them all/

Paul Sheard of S&P take a more “glass half full” approach. He says the optimal policy should be more fiscal stimulus and then some sort of agreement about reforming social security down the road. Most would agree that no more fiscal drag should be put on the economy now. But in the longer-term, you have people living longer and healthier. Unless you raise taxes or increase productivity, society will not be able to meet the demands of these benefits.

Republicans and Democrats will disagree, but they should agree on some issues. These are generational issues but they don’t need to be solved now. The dysfunction comes from the fact that they all say they ned to agree on the changes now.

Lewis Alexander, chief economist at Nomura, is also speaking. He says there is a risk that we’ve begun a process that will make Treasurys less central to this debate over spending. For risk managers, what we went through in October with the debt ceiling debate was a crisis. It was a low probabiltiy, but a high enough probability that we have to think about it.

Paul Sheard takes a more optimistic view of the new debt ceiling deadline early next year. The last debate had the feeling of the Tea Party grabbing the stearing wheel from House Speaker Boehner, and crashing, he said. They tried it once, but they won’t try it again.

Lewis Alexander is also hopeful that it won’t be as divisive as the last go round. Nonetheless, Boehner may feel the need to repeat what happened, he said. “Our political system has evolved in a way that makes it harder to do things,” he said of longer-term fiscal reforms.

Paul Sheard, ever the optimist, says Washington more or less got it right, though they made mistakes by putting on the fiscal brakes too soon. But this is the largest economy in the world, and the energy boom and the IT space both serve as bright spots for the economy uninhibited by the government, he asserts.

A final thought from Lewis Alexander: “Are you a substitute or a complement to a computer? If you are a substitute for a computer this a bad world for you. If you are a complement to a computer, this is a good world for you.”

Google or Goldman: Where should today’s bright young graduates go? Next up is a debate, with Yale’s Robert Shiller arguing for Goldman, while Vivek Wadwha of Singularity University makes the case for Google.

Shiller says lots of bright students who want to make a positive social impact feel they couldn’t possibly go into finance these days, and that’s too bad. “Every human activity that matters has to be financed,” Shiller says, which means a financier can have a much broader impact than any Google employee.

Shiller says he wants to introduce his students to a venture capitalist who specializes in health care. “When you study finance you are studying how to make things happen” and that has to matter more than getting on board at Google and “programming some little gimmick,” he says.

The gloves are off! Wadwha says that when he thinks of financial innovation, he thinks of things like CDOs, and other instruments that were at the heart of the financial crisis.

Google, on the other hand, is helping to come up with things that are changing the fabric of daily life.

“The United States is reinventing itself” and is in a rebound driven by technology, says Wadwha, who is vice president for innovation at Singularity University, which focuses on new technologies and startups.

Would you rather your children “cook up” more bubbles in the world of finance.

“The United States appears to be the nicest house on a relatively ugly block,” says Froman of the economy, citing political risk as the biggest blight. Exports have been growing 12% a year since 2009, making up one-thrid of GDP growth, but it’s expected to slow.

President is pursuing the biggest trade agenda in U.S. history, which aims to raise the standards of international trade and strengthen the multilateral trading system, Froman said. The Obama Administration wants to raise standards among growing group of like-minded nations until they become standard.

Is globalization about to unwind? That’s the brief of the next panel, featuring Susan Lund, principal at the McKinsey Global Institute and March Standish, co-chief executive of RBC Capital Markets and RBC Investor & Treasury Services.

All trade flows are down. That’s in part due to turmoil in the euro zone, where banks and companies have pulled assets from other euro countries. But the pendulum globally seems to be swinging against further financial integration.

Standish says more de-globalization is likely as is de-leveraging. Part of that is the fact that some entities had too much sovereign exposure. But it’s hard to say where the process is going to start, Standish says.

Some countries have already implemented Basel III capital rules, while other regulations are also in play, Standish says.

Meanwhile, if you’re a local bank in the euro zone getting beaten up by politicians for not making domestic loans, the first thing that’s going to get cut is international lending, Standish says.

As soon as we see tapering, you will see much more differentiation between securities, Standish says. Markets got a taste of that when emerging-markets took it on the chin when the Fed earlier this year broached the possibility of an eventual tapering.

The notion of being a global bank doesn’t exist any more, Standish says. Banks will be focusing their resources where they can do clients good. RBC sees itself as an “international bank” rather than a “global bank,” he says.

Banks used to be pillars of their local communities and have lost that, but have got “religion” since the crisis, Standish says.

Start-ups are having another moment, but what is their value to the economy? To investors? Those attempting to answer those questions in the last panel of the day include: Alan Patricof of Greycroft LLC, Kyle Kimball of the New York City Economic Development Corporation, and Greg Selkoe of the Future Boston Alliance and Karmaloop.

Patricof, whose Greycroft LLC invests in early-stage internet companies, says there’s tremendous excitement about tech startups. People are “indoctrinated” with the idea of working for themselves, but the world needs less new startups and more building up of the current ones. There’s not enough capital to keeping them all going.

There’s a debate in tech circles in New York about just how fast the tech sector is growing, says Kimball. It’s difficult to distringuish between who works for a tech company, and who works for a media company. It’s all blending together, Kimball says. The NYCEDC is working to create the underlying conditions for companies to continue to flourish in such a fashion, he says.

In Boston, the emphasis has been on transforming the city, rather than New York’s approach of harnessing its current core to attract start-ups. The idea was create a whole section of the city — the Innovation District — devoted to startups. “There’s been a lot of emphasis on trying to make the city more fun,” says Selkoe.

Start-up leaders don’t seem to be focused on fiscal issues, whose impact on the economy has dominated conversation this afternoon. “Most people who I’ve met in the start-up world don’t have the slightest care,” said Patricof. For starters, most start-ups are financed with equity, rather than debt, so the bond markets are necessarily a concern.

Kimball adds that if there were a top policy issue among start-up firms, it is immigration.

Story Conversation

About The Tell

The Tell is MarketWatch’s fast and engaging look at trends and themes in the day’s markets. Drawing on our reporters, analysts and commentators around the world, as well as selecting the best of the rest online, The Tell is all about the pulse of the markets through news, insight and strategic information to help you make the best investing decisions. Got a tip? Tell us at TheTell@MarketWatch.com